China can now focus on critical economic issues and accommodate the realities of a post-coronavirus world.
The removal of a GDP growth target for China is sensible, given the current circumstances, as setting a lower, more feasible target may have sent negative signals to global markets.
Released from its GDP target, China can now focus on critical issues facing the economy such as employment, social stability and national security and begin to accommodate the realities of a world that has only just started limping back to normality following COVID-19 related disruptions.
Over the years, the responsiveness of GDP growth to monetary stimulus has faded, meaning that China has had to generate significantly more money to drive GDP growth, leading to a steep rise in Chinese debt with total debt to GDP approaching 280 per cent at the end of 2019.
In China’s top-down growth model, provinces aim to meet or exceed targets set by the central leadership without, it might be argued, paying much attention to unintended consequences like increased debt.
Higher Quality Growth May Be the Goal
My hope is that this move to drop the GDP target will replace this aggressive headline growth pursuit with more sustainable, higher quality growth.
Breaking away from this tradition is part of a new growth strategy that China has embraced in recent years.
For example, in the last few years, China’s leaders have repeatedly stressed “growth with Chinese characteristics,” which has tried to shift the narrative away from headline growth towards other societal initiatives such as environmental concerns, up-scaling of jobs, creation of a vibrant technology sector and better standards of living.
At this stage, I would not be surprised if China’s leadership came up with a new way to measure progress, one that combines growth with other social variables.
Reasons for the Shift in China’s Approach
This shift in China’s approach to growth has both a cyclical and a structural element to it.
The cyclical element is easily understood and is linked to the current state of the world economy, which the International Monetary Fund predicts to contract 3 per cent in real terms in 2020 with developed economies shrinking 6 per cent, emerging economies declining 1 per cent and China doing relatively better with projected positive growth of 1.2 per cent.
However, the structural element is even more interesting, where traditional growth drivers have weakened.
China has already achieved significant urbanisation of its economy over the years. Incrementally, though, urbanisation will add less to growth than it did in the past.
But efforts to build economic clusters of excellence, such as the Greater Bay Area project, will continue to provide some boosts.
Further, China already is a very large producer of several commodities and exports more goods than any other country in the world – it exported US$2.6 trillion of goods in the 12 months ending March versus US$2.5 trillion by the U.S. and US$1.45 trillion by Germany. Increasing export market share will be challenging, especially in an environment where barriers to trade are rising.
Demographically, China’s working age population growth has stalled or may have even started declining.
Finally, there is little room for any pronounced uplift through financial deepening (enabling financing to all sections of society) given overall debt levels are fairly high.
This leaves domestic consumption, new technologies and services as the key growth drivers until the One Belt One Road Initiative starts creating demand for goods. Here, the focus on services is critical.
In the first phase of China’s transition to a world economic power, primary activities (agriculture) were increasingly replaced by secondary activities (industrial output). The second phase is seeing China transition to a consumption economy with services playing an incrementally larger role.
Service sector growth is less capital intensive but generates higher employment per unit of output than industrial.
What this tells us is that China’s growth focus has understandably sharpened with employment as the focal point, along with an attempt to move up the value chain in goods and services.
Expect Further Opening Up of China’s Economy
Looking ahead, we expect China will open its economy further, particularly in sectors like financial services where the potential for growth is huge given the size of its financial markets and the huge domestic savings pool.
Infrastructure spending will remain important but will be directed towards social housing, transportation and new economies, such as 5G technology, power grids and developing clusters of economic excellence.
We have already started to see a modest rise in Chinese consumption, as evidenced in April’s retail figures, which signals a gradual return of the Chinese consumer, aided by the resumption of broad economic activity.
I believe China’s GDP will expand in the second half of the year, assuming COVID-19 effects are contained not just in China, but globally.
However, the US-China relationship, along with anticipated further monetary policy changes or fiscal stimulus, has the potential to significantly impact the speed of the market’s recovery.
Against the backdrop of high investor caution, the secular growth sectors in China may benefit from the ongoing changes in the Chinese economy, including domestic consumption and technology.